Tesco pulls out of South Korea to dent UK debt pile

The divestment is expected to bring in £3.35bn in cash for the troubled supermarket, but will this latest move be enough to turn around the struggling UK business?

Jermaine Haughton

The UK’s largest supermarket has sacrificed its successful South Korean venture Homeplus retail stores, as chief executive Dave Lewis continues his attempts to address the company’s crumbling balance sheet.

Marking Tesco’s entry into the profitable South Korean consumer market in 1999, the Homeplus stores were a clever joint venture with electronics giant Samsung, utilising the tech brand’s popularity and experience in the Far East nation.

Unlike other foreign speculators, France’s Carrefour and US giant Walmart, Homeplus’s 1,075 stores and 139 shopping malls managed to gain some traction with local buyers, aided by features such as a cultural centre providing cooking and English lessons. Over 16 years, the Tesco venture also built 140 hypermarkets across South Korea, only comparable to domestic stalwarts E-Mart (155) and Lotte (114).

Judged by sales, Homeplus is the second-biggest firm in the industry.

However the last 24 chaotic months for Tesco, including a record pre-tax loss of £6.4bn for the year to February, has forced the retailer’s hand in selling its South Korean asset for £4.2bn to private equity firm MBK. The sale is expected to be worth £3.35bn in cash for Tesco, once taxes and other costs are deducted, and is expected to help reduce the group’s net debt of £9.3bn according to Standard and Poor’s.

Tesco boss Dave Lewis, nicknamed “Drastic Dave” due to his reputation as a ruthless decision-maker, said: "This sale realises material value for shareholders and allows us to make significant progress on our strategic priority of protecting and strengthening our balance sheet."

Troubled times

Replacing Philip Clarke as the retailer’s CEO last October, Lewis has had to steer the company through a number of crises, starting with the news that Tesco misstated profits by £263m last year.

In an increasingly saturated industry, Tesco has also suffered a loss of market share in the UK due to a fierce food price war with discount supermarkets Aldi and Lidl.

In the 12 weeks leading to March 2015, Aldi reported a 0.7 percentage point rise in its grocery market share to 5% compared to same period in 2014, according to research firm Kantar Worldpanel. By contrast, Tesco’s market share fell by 0.1 percentage points to 28.7% over the same period.

Changes to consumer behaviour, preferring shopping frequently throughout the week rather than a single weekly visit, and the revival of upmarket chain Waitrose has left Tesco “stuck in the middle”, according to industry commentators, leaving the retailer’s previous strategy outdated.

Since the turn of the century, sales more than tripled from £20bn to almost £70bn for Tesco. But within the same period net debt levels – total debts less cash on the balance sheet – jumped from £2.1bn to £9bn. The chain also has liabilities under operating lease commitments, stemming from when Tesco sold its property assets and rented them back on long-term contracts to accelerate growth and maintain dividend payments.

Amongst this intense pressure to satisfy customers, investors, employees and regulators, Lewis has made regaining formerly loyal Tesco shoppers a major goal. He aims to achieve this by promising to lower grocery prices, but with significant debts still hanging over the business these cuts cannot be too large.

Improved credit rating?

As the first major sale by Tesco since Lewis’ arrival, the divestment of Homeplus could be very important in improving the supermarket's credit rating. At present, two of the most important credit rating agencies, Standard and Poor's and Moody's, have Tesco at the lowest rating – junk.

By paying off its debts, Tesco will eventually find it easier to borrow money at a cheaper rate and pay less to insure itself against the possibility of default. Lewis said the money from the sale of Homeplus would be used primarily to redeem bonds and other commercial debt over the next 18 months, but might also be used to purchase the leases on some UK stores.

Sven Reinke, senior credit officer at Moody’s, said: “Our rating already anticipated that Tesco could enter into a transaction of this size. This announcement eases the negative pressure on the current rating. However, for positive pressure, Tesco’s underlying UK business needs to recover and I don’t think we are at that stage yet. We see signs of stabilisation but not of a sustainable recovery.”

Theoretically, greater borrowing capabilities can allow the leading UK supermarket chain to fund investment in its domestic operations, as it streamlines its services and builds a new and brighter future.

But while the sale of Homeplus will provide some welcome funds, there is still a long way to go before the company’s restructure is complete. Market research unit Dunnhumby, the company behind the Tesco Clubcard, and Tesco Broadband are among other assets up for sale, while further divestment is planned for ventures in Turkey and China.

Only time will tell if this is enough to return Tesco to a profitable future.

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